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 Financial Mathematics for
Actuaries Second Edition

10564hc_9789813224667_tp.indd 1 27/4/17 11:04 AM

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 Financial Mathematics for
Actuaries Second Edition

Wai-Sum Chan The Chinese University of Hong Kong, Hong Kong

Yiu-Kuen Tse Singapore Management University, Singapore

World Scientific
NEW JERSEY • LONDON • SINGAPORE • BEIJING • SHANGHAI • HONG KONG • TAIPEI • CHENNAI • TOKYO

10564hc_9789813224667_tp.indd 2 27/4/17 11:04 AM

 Published by
World Scientific Publishing Co. Pte. Ltd.
5 Toh Tuck Link, Singapore 596224
USA office: 27 Warren Street, Suite 401-402, Hackensack, NJ 07601
UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

British Library Cataloguing-in-Publication Data

A catalogue record for this book is available from the British Library.

FINANCIAL MATHEMATICS FOR ACTUARIES

Second Edition
Copyright © 2018 by World Scientific Publishing Co. Pte. Ltd.
All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or
mechanical, including photocopying, recording or any information storage and retrieval system now known or to
be invented, without written permission from the publisher.

For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center,
Inc., 222 Rosewood Drive, Danvers, MA 01923, USA. In this case permission to photocopy is not required from
the publisher.

ISBN 978-981-3224-66-7
ISBN 978-981-3224-67-4 (pbk)

Desk Editor: Shreya Gopi

Typeset by Stallion Press

Email: [email protected]

Printed in Singapore

Shreya - 10564 - Financial Mathematics for Actuaries.indd 1 03-07-17 5:20:14 PM

July 10, 2017 10:33 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-fm page v

To Bonnie, Nikki and Kevin

for their continuously compounded rate of support
Wai-Sum Chan

To Vicky, Germaine, Gerald and Gemma

for their unyielding forbearance
Yiu-Kuen Tse

v
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July 10, 2017 10:33 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-fm page vii

About the Authors

Wai-Sum Chan, PhD, FSA, HonFIA, CERA, graduated from the Chinese Univer-
sity of Hong Kong with a major in Accounting and a minor in Statistics. He pursued
a doctorate in Applied Statistics at the Fox School of Business Management, Tem-
ple University (Philadelphia, USA), receiving his PhD in 1989. He qualified as a
Fellow of the Society of Actuaries in 1995 and Chartered Enterprise Risk Analyst
in 2008. He was conferred an Honorary Fellow by the Institute and Faculty of
Actuaries in 2014. Dr Chan held teaching and research posts at the National Uni-
versity of Singapore, the University of Waterloo and the University of Hong Kong
before his present appointment as Professor of Finance at the Chinese University
of Hong Kong. Dr Chan’s research interests include Health Care Financing, Actu-
arial Modeling and Financial Econometrics. He has had over 100 scientific articles
published in scholarly journals. Dr Chan has been teaching financial and actuarial
courses since 1992.

Yiu-Kuen Tse, PhD, FSA, graduated from the University of Hong Kong,
majoring in Economics and Statistics. He obtained his MSc in Statistics and PhD
in Econometrics from the London School of Economics. He has been a Fellow of
the Society of Actuaries since 1993. Dr Tse’s research interests are in Empirical
Finance and Financial Econometrics. He is Professor of Economics at the School
of Economics, Singapore Management University. He has published extensively in
scholarly journals and is the author of the book Nonlife Actuarial Models: Theory,
Methods and Evaluation. Dr Tse teaches undergraduate Actuarial Science and is
also involved in many executive training programs.
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July 10, 2017 10:33 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-fm page ix

Preface to the Second Edition

A good understanding of the fundamental concepts of financial mathematics is

essential for the evaluation of any financial product and instrument. Mastering
concepts of present and future values of streams of cash flows under different inter-
est rate environments is core for actuaries and financial economists. It is with these
perspectives in mind that we write this textbook.
This book covers the body of knowledge required by the Society of Actuaries
(SOA) for its Financial Mathematics (FM) Exam. In this second edition, we
expand the book to include topics introduced by the SOA in the FM Exam from
2017 onwards. In particular, in Chapter 3 we include the coverage of interest rate
swaps. We also add a chapter on the determination of the rates of interest of vari-
ous financial securities. Some institutional aspects of interest rate policies and the
economic management of Central Banks are also discussed in this chapter.
This book also has a chapter on stochastic interest rate models. Students study-
ing for the Institute and Faculty of Actuaries Exam CT1 will also find this book
suitable for the preparation of the exam.
It is our hope that students in an undergraduate course on financial mathematics
for actuaries will find this book useful. This book contains numerous examples and
exercises, some of which are adapted from previous SOA FM Exams. We believe
it is also useful for students preparing for the actuarial professional exams through
self-study.
Users of this book are assumed to have prior knowledge of high school al-
gebra and college level introductory calculus. An appendix on the preview of
mathematics and statistics is included for the benefits of students who require a
quick revision or occasional reference.
We continue to provide teaching aids to support instructors using this book for
teaching. Instructors who wish to obtain the instructors’ manual for the solutions
of the exercises and/or the slides for use in lectures may write to the publisher at:
[email protected].

Wai-Sum Chan, PhD FSA CERA Yiu-Kuen Tse, PhD FSA

Department of Finance School of Economics
Chinese University of Hong Kong Singapore Management University
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July 10, 2017 10:33 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-fm page xi

Contents

About the Authors vii

Preface to the Second Edition ix
Lists of Mathematical Symbols xv

Chapter 1 Interest Accumulation and Time Value of Money 1

1.1 Accumulation Function and Amount Function . . . . . . . . . . . 2
1.2 Simple and Compound Interest . . . . . . . . . . . . . . . . . . . 2
1.3 Frequency of Compounding . . . . . . . . . . . . . . . . . . . . 5
1.4 Effective Rate of Interest . . . . . . . . . . . . . . . . . . . . . . 9
1.5 Rates of Discount . . . . . . . . . . . . . . . . . . . . . . . . . . 12
1.6 Force of Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
1.7 Present and Future Values . . . . . . . . . . . . . . . . . . . . . . 19
1.8 Equation of Value . . . . . . . . . . . . . . . . . . . . . . . . . . 24
1.9 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Chapter 2 Annuities 39
2.1 Annuity-Immediate . . . . . . . . . . . . . . . . . . . . . . . . . 40
2.2 Annuity-Due . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
2.3 Perpetuity, Deferred Annuity and Annuity Values at Other Times . 45
2.4 Annuities under Other Accumulation Methods . . . . . . . . . . . 49
2.5 Payment Periods, Compounding Periods and Continuous Annuities 51
2.6 Varying Annuities . . . . . . . . . . . . . . . . . . . . . . . . . . 56
2.7 Term of Annuity . . . . . . . . . . . . . . . . . . . . . . . . . . 60
2.8 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
July 10, 2017 10:33 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-fm page xii

xii Contents

Chapter 3 Spot Rates, Forward Rates and the Term Structure 73

3.1 Spot and Forward Rates of Interest . . . . . . . . . . . . . . . . . 74
3.2 The Term Structure of Interest Rates . . . . . . . . . . . . . . . . 79
3.3 Present and Future Values Given the Term Structure . . . . . . . . 80
3.4 Accumulation Function and the Term Structure . . . . . . . . . . 85
3.5 Interest Rate Swaps . . . . . . . . . . . . . . . . . . . . . . . . . 90
3.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

Chapter 4 Rates of Return 105

4.1 Internal Rate of Return . . . . . . . . . . . . . . . . . . . . . . . 106
4.2 One-Period Rate of Return . . . . . . . . . . . . . . . . . . . . . 112
4.3 Rate of Return over Multiple Periods . . . . . . . . . . . . . . . . 116
4.4 Portfolio Return . . . . . . . . . . . . . . . . . . . . . . . . . . . 121
4.5 Short Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124
4.6 Crediting Interest: Investment-Year Method
and Portfolio Method . . . . . . . . . . . . . . . . . . . . . . . . 125
4.7 Capital Budgeting and Project Appraisal . . . . . . . . . . . . . . 127
4.8 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134

Chapter 5 Loans and Costs of Borrowing 147

5.1 Loan Balance: Prospective and Retrospective Methods . . . . . . 148
5.2 Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152
5.3 Sinking Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . 154
5.4 Varying Installments and Varying Interest Rates . . . . . . . . . . 159
5.5 Comparison of Borrowing Costs . . . . . . . . . . . . . . . . . . 163
5.6 Flat Rate Loan and Flat Rate Discount Loan . . . . . . . . . . . . 165
5.7 Borrowing Costs and Reference Rates . . . . . . . . . . . . . . . 168
5.8 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172

Chapter 6 Bonds and Bond Pricing 187

6.1 Basic Concepts . . . . . . . . . . . . . . . . . . . . . . . . . . . 188
6.2 Bond Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . 190
6.3 Bond Amortization Schedule . . . . . . . . . . . . . . . . . . . . 193
6.4 Valuation between Coupon-Payment Dates . . . . . . . . . . . . . 198
6.5 Callable Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . 202
6.6 Bond Pricing under a General Term Structure . . . . . . . . . . . 204
6.7 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207
July 10, 2017 10:33 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-fm page xiii

Contents xiii

Chapter 7 Bond Yields and the Term Structure 213

7.1 Some Simple Measures of Bond Yield . . . . . . . . . . . . . . . 214
7.2 Yield to Maturity . . . . . . . . . . . . . . . . . . . . . . . . . . 215
7.3 Par Yield . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 219
7.4 Holding-Period Yield . . . . . . . . . . . . . . . . . . . . . . . . 221
7.5 Discretely Compounded Yield Curve . . . . . . . . . . . . . . . . 225
7.6 Continuously Compounded Yield Curve . . . . . . . . . . . . . . 228
7.7 Term Structure Models . . . . . . . . . . . . . . . . . . . . . . . 232
7.8 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237

Chapter 8 Bond Management 245

8.1 Macaulay Duration and Modified Duration . . . . . . . . . . . . . 246
8.2 Duration for Price Correction . . . . . . . . . . . . . . . . . . . . 252
8.3 Convexity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254
8.4 Some Rules for Duration . . . . . . . . . . . . . . . . . . . . . . 256
8.5 Immunization Strategies . . . . . . . . . . . . . . . . . . . . . . 259
8.6 Some Shortcomings of Duration Matching . . . . . . . . . . . . . 272
8.7 Duration under a Nonflat Term Structure . . . . . . . . . . . . . . 274
8.8 Passive versus Active Bond Management . . . . . . . . . . . . . 277
8.9 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 278
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279

Chapter 9 Interest Rates and Financial Securities 291

9.1 Interest Rate Determination . . . . . . . . . . . . . . . . . . . . . 292
9.2 Financial Securities . . . . . . . . . . . . . . . . . . . . . . . . . 296
9.3 Inflation and Central Bank Policy . . . . . . . . . . . . . . . . . . 300
9.4 Macroeconomic Management . . . . . . . . . . . . . . . . . . . 301
9.5 Rate of Interest in an Open Economy . . . . . . . . . . . . . . . . 302
9.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 303

Chapter 10 Stochastic Interest Rates 305

10.1 Deterministic Scenarios of Interest Rates . . . . . . . . . . . . . . 306
10.2 Random-Scenario Model . . . . . . . . . . . . . . . . . . . . . . 307
10.3 Independent Lognormal Model . . . . . . . . . . . . . . . . . . . 310
10.4 Autoregressive Model . . . . . . . . . . . . . . . . . . . . . . . . 314
10.5 Dynamic Term Structure Model . . . . . . . . . . . . . . . . . . 316
10.6 An Application: Guaranteed Investment Income . . . . . . . . . . 317
10.7 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 320
Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 320
July 10, 2017 10:33 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-fm page xiv

xiv Contents

Appendix A Review of Mathematics and Statistics 327

A.1 Exponential Function . . . . . . . . . . . . . . . . . . . . . . . . 327
A.2 Logarithmic Function . . . . . . . . . . . . . . . . . . . . . . . . 327
A.3 Roots of a Quadratic Equation . . . . . . . . . . . . . . . . . . . 328
A.4 Arithmetic Progression . . . . . . . . . . . . . . . . . . . . . . . 328
A.5 Geometric Progression . . . . . . . . . . . . . . . . . . . . . . . 328
A.6 Some Derivatives . . . . . . . . . . . . . . . . . . . . . . . . . . 328
A.7 Integration by Part . . . . . . . . . . . . . . . . . . . . . . . . . . 329
A.8 Taylor Series Expansion . . . . . . . . . . . . . . . . . . . . . . . 329
A.9 Binomial Expansion . . . . . . . . . . . . . . . . . . . . . . . . . 329
A.10 Expected Value and Variance of a Random Variable . . . . . . . . 330
A.11 Mean and Variance of Sum of Random Variables . . . . . . . . . 330
A.12 Uniform Distribution . . . . . . . . . . . . . . . . . . . . . . . . 330
A.13 Normal Distribution . . . . . . . . . . . . . . . . . . . . . . . . . 331
A.14 Lognormal Distribution . . . . . . . . . . . . . . . . . . . . . . . 331

Appendix B Answers to Selected Exercises 333

Index 349
July 10, 2017 10:33 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-fm page xv

List of Mathematical Symbols

Symbol Meaning

an
same as an
i when the rate of interest is understood

an
i present value of an annuity-immediate
q| an
i present value of a q-period deferred annuity-immediate
a∞
present value of a perpetuity-immediate
(m) (m)
an
same as an
when the rate of interest is understood
i
(m)
an
present value of an mn-payment annuity-immediate with
i
m payments per interest-conversion period
(m)
q| an
i present value of a q-period deferred, mn-payment
annuity-immediate with m payments per interest-conversion period
än
same as än
i when the rate of interest is understood
än
i present value of an annuity-due
q| än
i present value of a q-period deferred annuity-due
ä∞
present value of a perpetuity-due
(m) (m)
än
same as än
when the rate of interest is understood
i
(m)
än
present value of an mn-payment annuity-due with
i
m payments per interest-conversion period
(m)
q| än
i present value of a q-period deferred, mn-payment annuity-due
with m payments per interest-conversion period
ān
present value of a continuous annuity
q| ān
present value of a q-period deferred continuous annuity
a(t) accumulation function at time t
at (τ ) accumulation function for a forward payment due at time t
A(t) amount function at time t
July 10, 2017 10:33 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-fm page xvi

xvi List of Mathematical Symbols

Symbol Meaning

BjA fund value after transaction at time tj

BjB fund value before transaction at time tj
d rate of discount
d(m) nominal rate of discount payable m times a year
δ constant force of interest
δ(t) force of interest at time t
D Macaulay duration
D∗ modified duration
DF Fisher-Weil duration
(Da)n
present value of a decreasing annuity-immediate
(Dä)n
present value of a decreasing annuity-due
(Dā)n
present value of a decreasing continuous annuity
(D̄ā)n
present value of a continuously decreasing continuous annuity
(Ds)n
future value of a decreasing annuity-immediate
(Ds̈)n
future value of a decreasing annuity-due
(Ds̄)n
future value of a decreasing continuous annuity
(D̄s̄)n
future value of a continuously decreasing continuous annuity
i constant annual effective rate of interest
iH one-year holding yield
iP par yield of a bond
iYt investment-year credit rate at year t
i(t) annual effective rate of interest for year t
i(t, t + n) annual effective rate of interest in the period t to t + n
iFt forward rate of interest
iFt,τ annualized forward rate of interest over τ periods from t to t + τ
iSt spot rate of interest
S the spot rate of interest applicable to period t to t + τ
t iτ

I(t) interest incurred in period t

July 10, 2017 10:33 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-fm page xvii

List of Mathematical Symbols xvii

Symbol Meaning

(Ia)n
present value of an increasing annuity-immediate

(Iä)n
present value of an increasing annuity-due
(Iā)n
present value of an increasing continuous annuity
(I¯ā)
n present value of a continuously increasing continuous annuity
(Is)n
future value of an increasing annuity-immediate
(I s̈)n
future value of an increasing annuity-due
(I s̄)n
future value of an increasing continuous annuity
(I¯s̄)

n future value of a continuously increasing continuous annuity
r (m) nominal rate of interest payable m times a year
r̄ continuously compounded rate of interest
rI rate of inflation
rN nominal rate of interest
rR real rate of interest
RA arithmetic mean rate of return
RB interest rate for borrowing
RD one-period DWRR (dollar-weighted rate of return)
RG geometric mean rate of return
RL interest rate for lending
RP rate of return for a portfolio
RS swap rate of an interest rate swap
RT one-period TWRR (time-weighted rate of return)
s n
same as sn
i when the rate of interest is understood
sn
i future value of an annuity-immediate
q| sn
i future value of a q-period deferred annuity-immediate
(m) (m)
s n
same as sn
when the rate of interest is understood
i
(m)
s n
future value of an mn-payment annuity-immediate with
i
m payments per interest-conversion period
July 10, 2017 10:33 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-fm page xviii

xviii List of Mathematical Symbols

Symbol Meaning

(m)
q| sn
i future value of an q-period deferred, mn-payment
annuity-immediate with m payments per interest-conversion period
s̈n
same as s̈n
i when the rate of interest is understood
s̈n
i future value of an annuity-due
q| s̈n
i future value of a q-period deferred annuity-due
(m) (m)
s̈n
same as s̈n
when the rate of interest is understood
i
(m)
s̈n
future value of an mn-payment annuity-due with
i
m payments per interest-conversion period
(m)
q| s̈n
i future value of a q-period deferred, mn-payment annuity-due
with m payments per interest-conversion period
s̄n
present value of a continuous annuity
q| s̄n
present value of a q-period deferred continuous annuity
v discount factor
v(t) present value of 1 to be paid at time t
July 10, 2017 10:31 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-ch01 page 1

1 Interest Accumulation and

Time Value of Money

From time to time we are faced with problems of making financial

decisions. These may involve anything from borrowing a loan from
a bank to purchase a house or a car; or investing money in bonds,
stocks or other securities. To a large extent, intelligent wealth man-
agement means borrowing and investing wisely.

Financial decision making should take into account the time value of
money. It is not difficult to see that a dollar received today is worth
more than a dollar received one year later. The time value of money
depends critically on how interest is calculated. For example, the
frequency at which the interest is compounded may be an important
factor in determining the cost of a loan.

In this chapter, we discuss the basic principles in the calculation of

interest, including the simple- and compound-interest methods, the
frequencies of compounding, the effective rate of interest and rate of
discount, and the present and future values of a single payment.
July 10, 2017 10:31 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-ch01 page 2

2 CHAPTER 1

Learning Objectives

• Basic principles in calculation of interest accumulation

• Simple and compound interest
• Frequency of compounding
• Effective rate of interest
• Rate of discount
• Present and future values of a single payment

1.1 Accumulation Function and Amount Function

Many financial transactions involve lending and borrowing. The sum of money
borrowed is called the principal. To compensate the lender for the loss of use of
the principal during the loan period the borrower pays the lender an amount of in-
terest. At the end of the loan period the borrower pays the lender the accumulated
amount, which is equal to the sum of the principal plus interest.
We denote A(t) as the accumulated amount at time t, called the amount func-
tion. Hence, A(0) is the initial principal and

I(t) = A(t) − A(t − 1) (1.1)

is the interest incurred from time t − 1 to time t, namely, in the tth period. For
the special case of an initial principal of 1 unit, we denote the accumulated amount
at time t by a(t), which is called the accumulation function. Thus, if the initial
principal is A(0) = k, then
A(t) = k × a(t).
This assumes that the same accumulation function is used for the amount function
irrespective of the initial principal.

1.2 Simple and Compound Interest

Equation (1.1) shows that the growth of the accumulated amount depends on the
way the interest is calculated, and vice versa. While theoretically there are
July 10, 2017 10:31 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-ch01 page 3

Interest Accumulation and Time Value of Money 3

numerous ways of calculating the interest, there are two methods which are com-
monly used in practice. These are the simple-interest method and the compound-
interest method.
For the simple-interest method, the interest earned over a period of time is
proportional to the length of the period. Thus the interest incurred from time 0
to time t, for a principal of 1 unit, is r × t, where r is the constant of proportion
called the rate of interest. Hence the accumulation function for the simple-interest
method is
a(t) = 1 + rt, for t ≥ 0, (1.2)
and
A(t) = A(0)a(t) = A(0)(1 + rt), for t ≥ 0. (1.3)
In general the rate of interest may be quoted for any period of time (such as a
month or a year). In practice, however, the most commonly used base is the year,
in which case the term annual rate of interest is used. In what follows we shall
maintain this assumption, unless stated otherwise.
Example 1.1: A person borrows $2,000 for 3 years at simple interest. The rate
of interest is 8% per annum. What are the interest charges for year 1 and 2? What
is the accumulated amount at the end of year 3?
Solution: The interest charges for year 1 and 2 are both equal to

2,000 × 0.08 = $160.

The accumulated amount at the end of year 3 is

2,000 (1 + 0.08 × 3) = $2,480.

For the compound-interest method, the accumulated amount over a period of

time is the principal for the next period. Thus, a principal of 1 unit accumulates to
1 + r units at the end of the year, which becomes the principal for the second year.
Continuing this process, the accumulation function becomes

a(t) = (1 + r)t , for t = 0, 1, 2, · · · , (1.4)

and the amount function is

A(t) = A(0)a(t) = A(0)(1 + r)t , for t = 0, 1, 2, · · · . (1.5)

Two remarks are noted. First, for the compound-interest method the accumu-
lated amount at the end of a year becomes the principal for the following year.
July 10, 2017 10:31 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-ch01 page 4

4 CHAPTER 1

This is in contrast to the simple-interest method, for which the principal remains
unchanged through time. Second, while (1.2) and (1.3) apply for t ≥ 0, (1.4) and
(1.5) hold only for integral t ≥ 0. As we shall see below, there are alternative ways
to define the accumulation function for the compound-interest method when t is
not an integer.

Example 1.2: Solve the problem in Example 1.1 using the compound-interest
method.

Solution: The interest for year 1 is

2,000 × 0.08 = $160.

For year 2 the principal is

2,000 + 160 = $2,160,

so that the interest for the year is

2,160 × 0.08 = $172.80.

The accumulated amount at the end of year 3 is

2,000 (1 + 0.08)3 = $2,519.42.

Compounding has the effect of generating a larger accumulated amount. The

effect is especially significant when the rate of interest is high. Table 1.1 shows
two samples of the accumulated amounts under simple- and compound-interest
methods. It can be seen that when the interest rate is high, compounding the interest
induces the principal to grow much faster than the simple-interest method.
With compound interest at 10%, it takes less than 8 years to double the invest-
ment. With simple interest at the same rate it takes 10 years to get the same result.
Over a 20-year period, an investment with compound interest at 10% will grow
6.73 times. Over a 50-year period, the principal will grow by a phenomenal 117.39
times. When the interest rate is higher the effect of compounding will be even more
dramatic.
July 10, 2017 10:31 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-ch01 page 5

Interest Accumulation and Time Value of Money 5

Table 1.1: Accumulated amount for a principal of $100

5% interest 10% interest

Year Simple Compound Simple Compound
interest ($) interest ($) interest ($) interest ($)

1 105.00 105.00 110.00 110.00

2 110.00 110.25 120.00 121.00
3 115.00 115.76 130.00 133.10
4 120.00 121.55 140.00 146.41
5 125.00 127.63 150.00 161.05
6 130.00 134.01 160.00 177.16
7 135.00 140.71 170.00 194.87
8 140.00 147.75 180.00 214.36
9 145.00 155.13 190.00 235.79
10 150.00 162.89 200.00 259.37

1.3 Frequency of Compounding

Although the rate of interest is often quoted in annual term, the interest accrued to
an investment is often paid more frequently than once a year. For example, a sav-
ings account may pay interest at 3% per year, where the interest is credited monthly.
In this case, 3% is called the nominal rate of interest payable 12 times a year. As we
shall see, the frequency of interest payment (also called the frequency of com-
pounding) makes an important difference to the accumulated amount and the total
interest earned. Thus, it is important to define the rate of interest accurately.
To emphasize the importance of the frequency of compounding we use r (m)
to denote the nominal rate of interest payable m times a year. Thus, m is the
1
frequency of compounding per year and m year is the compounding period or
conversion period.
1
Let t (in years) be an integer multiple of m , i.e., tm is an integer representing
the number of interest-conversion periods over t years. The interest earned over the
1 1
next m year, from time t to t + m , is

1 a(t)r (m) 1 2
a(t) × r (m) × = , for t = 0, , ,··· .
m m m m
July 10, 2017 10:31 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-ch01 page 6

6 CHAPTER 1

1
Thus, the accumulated amount at time t + m is

  
1 a(t)r (m) r (m) 1 2
a t+ = a(t)+ = a(t) 1 + , for t = 0, , ,··· .
m m m m m

By recursive substitution, we conclude

 mt
r (m) 1 2
a(t) = 1 + , for t = 0, , ,··· , (1.6)
m m m

and hence
 mt
r (m) 1 2
A(t) = A(0) 1 + , for t = 0, , ,··· . (1.7)
m m m

Example 1.3: A person deposits $1,000 into a savings account that earns 3%
interest payable monthly. How much interest will be credited in the first month?
What is the accumulated amount at the end of the first month?
Solution: The rate of interest over one month is
1
0.03 × = 0.25%,
12
so that the interest earned over one month is
1,000 × 0.0025 = $2.50,
and the accumulated amount after one month is
1,000 + 2.50 = $1,002.50.


Example 1.4: $1,000 is deposited into a savings account that pays 3% interest
with monthly compounding. What is the accumulated amount after two and a half
years? What is the amount of interest earned over this period?
Solution: The investment interval is 30 months. Thus, using (1.7), the accumu-
lated amount is  
0.03 30
1,000 1 + = $1,077.78.
12
The amount of interest earned over this period is
1,077.78 − 1,000 = $77.78.


July 10, 2017 10:31 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-ch01 page 7

Interest Accumulation and Time Value of Money 7

Example 1.5: Solve the problem in Example 1.4, assuming that the interest is
paid quarterly.
Solution: The investment interval is now 10 quarters. With m = 4, the accumu-
lated amount is  
0.03 10
1,000 1 + = $1,077.58,
4
and the amount of interest earned is $77.58.

When the loan period is not an integer multiple of the compounding period (i.e.,
tm is not an integer), care must be taken to define the way interest is calculated
over the fraction of the compounding period. Two methods may be considered.
First, we may extend (1.6) and (1.7) to apply to any tm ≥ 0 (not necessarily an
integer). Second, we may compute the accumulated value over the largest integral
interest-conversion period using (1.7) and then apply the simple-interest method
to the remaining fraction of the conversion period. The example below illustrates
these two methods.

Example 1.6: What is the accumulated amount for a principal of $100 after 25
months if the nominal rate of interest is 4% compounded quarterly?
Solution: The accumulation period is 253 = 8.33 quarters. Using the first
method, the accumulated amount is
 
0.04 8.33
100 1 + = $108.64.
4

Using the second method the accumulated amount after 24 months (8 quarters) is
 8
0.04
100 1 + = $108.29,
4
so that the accumulated amount after 25 months is
 
1
108.29 1 + 0.04 × = 108.65.
12

July 10, 2017 10:31 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-ch01 page 8

8 CHAPTER 1

It can be shown that the second method provides a larger accumulation function
for any non-integer tm > 0 (see Exercise 1.41). As the first method is easier
to apply, we shall adopt it to calculate the accumulated value over a non-integral
compounding period, unless otherwise stated.
At the same nominal rate of interest, the more frequent the interest is paid, the
faster the accumulated amount grows. For example, assuming the nominal rate of
interest to be 5% and the principal to be $1,000, the accumulated amounts after 1
year under several different compounding frequencies are given in Table 1.2.
Note that when the compounding frequency m increases, the accumulated
amount tends to a limit. Let r̄ denote the nominal rate of interest for which com-
pounding is made over infinitely small intervals (i.e., m → ∞ so that r̄ = r (∞) ).
We call this compounding scheme continuous compounding. For practical pur-
poses, daily compounding is very close to continuous compounding.
From the well-known limit theorem (see Appendix A.1) that
 r̄ m
lim 1 + = er̄ (1.8)
m→∞ m
for any constant r̄, we conclude that, for continuous compounding, the accumula-
tion function (see (1.6)) is
  
r̄ mt r̄ m t
a(t) = lim 1 + = lim 1 + = er̄t . (1.9)
m→∞ m m→∞ m

We call r̄ the continuously compounded rate of interest. Equation (1.9) provides

the accumulation function of the continuously compounding scheme at nominal
rate of interest r̄.

Table 1.2: Accumulated amount for a principal of $1,000

with nominal interest rate of 5% per annum

Frequency of Accumulated
interest payment m amount ($)
Yearly 1 1,050.00
Quarterly 4 1,050.95
Monthly 12 1,051.16
Daily 365 1,051.27
July 10, 2017 10:31 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-ch01 page 9

Interest Accumulation and Time Value of Money 9

1.4 Effective Rate of Interest

As Table 1.2 shows, the accumulated amount depends on the compounding fre-
quency. Hence, comparing two investment schemes by just referring to their nom-
inal rates of interest without taking into account their compounding frequencies
may be misleading. Different investment schemes must be compared on a common
basis. To this end, the measure called the effective rate of interest is often used.
The annual effective rate of interest for year t, denoted by i(t), is the ratio of the
amount of interest earned in a year, from time t − 1 to time t, to the accumulated
amount at the beginning of the year (i.e., at time t − 1). It can be calculated by the
following formula

I(t) A(t) − A(t − 1) a(t) − a(t − 1)

i(t) = = = . (1.10)
A(t − 1) A(t − 1) a(t − 1)

For the simple-interest method, we have

(1 + rt) − (1 + r(t − 1)) r

i(t) = = ,
1 + r(t − 1) 1 + r(t − 1)

which decreases when t increases.

For the compound-interest method with annual compounding (i.e., m = 1), we
have (denoting r (1) = r)

(1 + r)t − (1 + r)t−1
i(t) = = r,
(1 + r)t−1

which is the nominal rate of interest and does not vary with t. When
m-compounding is used, the effective rate of interest is
 tm  (t−1)m
r (m) r (m)
1+ − 1+  m
m m r (m)
i(t) =  (t−1)m = 1+ − 1, (1.11)
m
r (m)
1+
m

which again does not vary with t. Note that when m > 1,
 m
r (m)
1+ − 1 > r (m) ,
m

so that the effective rate of interest is larger than the nominal rate of interest.
July 10, 2017 10:31 Financial Mathematics for Actuaries, 2nd Edition 9.61in x 6.69in b3009-ch01 page 10

10 CHAPTER 1

For continuous compounding, we have

exp(r̄t) − exp[r̄(t − 1)]
i(t) = = er̄ − 1, (1.12)
exp[r̄(t − 1)]
which again does not vary with t.
As the effective rate of interest for the compound-interest method does not vary
with t, we shall simplify the notation and denote i ≡ i(t), which is given by (1.11)
or (1.12). The effective rate of interest shows how much interest is earned in one
year with a 1-unit investment. It is an appropriate standardized measure to com-
pare interest-accumulation schemes with different compounding frequencies and
nominal rates of interest.
Example 1.7: Consider two investment schemes A and B. Scheme A offers 12%
interest with annual compounding. Scheme B offers 11.5% interest with monthly
compounding. Calculate the effective rates of interest of the two investments.
Which scheme would you choose?
Solution: The effective rate of interest of Scheme A is equal to its nominal rate
of interest, i.e., 12%. The effective rate of interest of Scheme B is
 
0.115 12
1+ − 1 = 12.13%.
12
Although Scheme A has a higher nominal rate of interest, Scheme B offers a higher
effective rate of interest. Hence, while an investment of $100 in Scheme A will
generate an interest of $12 after one year, a similar investment in Scheme B will
generate an interest of $12.13 over the same period. Thus, Scheme B is preferred.


Another advantage of the effective rate of interest is that, for investments that
extend beyond one year, the calculation of the accumulated amount can be based
on the effective rate without reference to the nominal rate.
Example 1.8: For the investment schemes in Example 1.7, calculate the accumu-
lated amount after 10 years on a principal of $1,000.
Solution: The accumulated amount after 10 years for Scheme A is
1,000 (1 + 0.12)10 = $3,105.85,
and that for Scheme B is
1,000 (1 + 0.1213)10 = $3,142.09.
Note that in the above example, the accumulated amount of Scheme B is calculated
without making use of its nominal rate.


Other documents randomly have
different content
gave him the report to take back. I shall never forget “Ducky’s” eyes,
sick with seeing horrors, as he turned to go.
As he disappeared, a tall figure came striding along from the right—
Capt. Fleischmann, with dark circles under his eyes, blackened and
stained from head to foot with blood and powder. We greeted each
other as risen from the dead, and compared notes. He had run into
the enemy in force strongly established in concrete pillboxes and
machine gun posts; and while scattered groups of his company had
won through to the company objective, they were unable to hold it
without machine guns against the enemy’s enfilading fire. The
remnant had retired to their old line of outguards, after suffering
heavy losses.
Since I still thought the 312th Inf. might be far out to our left front,
and depending on us to cover their ultimate withdrawal, we decided
that B Co. should hold on where we were, while D Co. would string
scattered Cossack posts along their old line until relief or further
orders came up.
The morning wore on; still no news from our left flank. I kept on the
move up and down the line, assuming a confidence that I did not
feel; for of course if the enemy advanced in any force we were done
for. Still we had our orders, and there was nothing for it but to put up
the best scrap we could.
Some things were funny, even then. I remember the company
barber, that sterling son of Italy, after a Boche sniper put a bullet past
each ear. He wriggled back from his unpleasant position on the crest
of the ridge, and retaliated by holding up his rifle at arm’s length over
his head, pointed northeast, and executing rapid fire, pulling the
trigger with his thumb, while he regarded my approach with the
complacence of conscious ingenuity. I think the Boche must have
laughed too; for the branches of a tree across the field began to
shake, and a bullet brought a gray body tumbling down from branch
to branch.
We had some food—hard bread, corned willy and goldfish—but very
little water. It was pitiful to see the wounded, who wouldn’t take any
from the others, because they were going back when the stretcher
bearers got around to them. Levy and his detail worked like Trojans,
but it was a long trip, and every time they returned there was a fresh
batch of wounded to be carried.
There was one man—I wish I could remember his name, but though
every event stands out clearly in my mind, I cannot remember the
names connected with them. He was sitting with his back against a
tree, wounded by a shell in the legs and stomach. When I asked him
if I could do anything for him, he said “If I could have a little water.” I
gave him my canteen, which had a couple of swallows left in it. He
shook it, and grinned and shook his head. “Not your last, Cap’n.” I
told him that Levy had just brought up a can, and hurried off to the
left, where the firing was getting heavy. When I passed that way
again, the man was dead. And the water was still in my canteen, and
he had screwed the stopper back on; so he must have thought I was
lying about Levy.
Three o’clock came, and shortly after a platoon from A Co. under Lt.
Bigler came up to reinforce us. They were posted on our left flank to
hold the ravine up which the enemy had been trying to advance and
flank our position. I couldn’t understand why the Germans in front of
D Co. had not come in on our right flank yet.
At 3:30 a patrol of two officers and six men came up the road on the
left, and as they drew near I recognized Capt. Gray, of the 312th Inf.,
who I knew commanded their outpost line. His news was not
encouraging. His company had received no orders to advance; they
were still on their old line to our left rear. We arranged that he should
run a line of Cossack posts along the road up to join us, so that we
would have at least a continuous line of outguards on the brigade
front. On the way over the ridge from his right flank post, his patrol
had had several skirmishes with German outposts or patrols; so the
enemy was apparently venturing back to the positions where our
patrol had flushed them earlier in the day.
Just after he left—about 5.30—Lt. Col. Budd came up with several
men. I was certainly glad to see him, and even more glad to see
Levy with a can of water, which he doled out, a swallow to each man.
Col. Budd looked over the situation, and decided that we should hold
the ridge until nightfall, when we would be relieved. While he was
there, three German snipers managed to get into a rifle pit on the
plateau about a hundred yards in front of us, and made things very
hot on the right flank. Sgt. Lehy took our last two rifle grenades, and
dropped the second one plumb into the pit, which discouraged those
three for the day.
Col. Budd departed to arrange for sending up water, ammunition and
the relief.
At 5:30 the enemy’s artillery started in on us again, sweeping the top
of the ridge with shell and shrapnel, and dropping time shells into the
ravine behind it. For twenty minutes he poured in a heavy barrage,
while we hugged the ground and gripped our rifles. If this meant a
counter-attack in force we were up against it, because our
ammunition was running low; but if we could beat them off once
more we might hold out until night brought the relief.
But this time the enemy was starting the real thing. He knew the
ground like a book, of course; and I must say that his attack was ably
planned and bravely executed. While his artillery shelled us,
machine guns worked around behind both our flanks. At 5:50 men
from D Co’s outguards came running in and reported that the enemy
had advanced in force, broken their skeleton line, and was coming in
on our right flank with machine guns. Even while they spoke, the
“Tap-tap-tap” of the machine gun broke out on the right to confirm
them, and our Chauchats spat back in answer.
In those woods, it was merely a question of who could throw enough
lead to keep the other fellow’s head down; and at this game our
Chauchats had the chance of the proverbial snowball. With Sgts.
Reid, Lehy, Fahey and Levy, the right flank, which had been
disorganized and driven in with the D Co. outposts, was re-formed,
and a firing line built up at right angles to our front to face our new
foes. The enemy in front was pouring in a hot fire; we could not
encircle the enemy machine guns to the right because of that belt of
wire behind us. Meanwhile those same machine guns were
enfilading our main line along the ridge.
Our only chance was a frontal attack on them. First we tried a series
of rushes. I realized then exactly what was meant by “fire
superiority,” and the enemy certainly had it. One Chauchat ran out of
ammunition. The other was in Cocker’s hands, and he used it well
until it jammed. He worked at it desperately for several minutes, as
he advanced with the line; then he threw it up against a tree in
disgust, crying bitterly “That’s a hell of a thing to give a man to fight
with.” From then on we had only our rifle fire against their leaden
hailstorm. Neither side could aim their shots, but they were shooting
twenty bullets to our one, and our hastily formed line was driven
back.
As they retired, Sgt. Fahey and I, with two other men, tried to sneak
up along the top of the ridge and get close enough to bomb one of
the machine guns. We were lucky at first, the enemy being busy with
his bullets further down the slope. We saw four Germans, carrying
ammunition ahead of us, but held our fire, hoping they would lead on
to their gun. Fahey slipped me a bomb, and I pulled the pin, ready to
throw. Just then a new devil’s tattoo broke out about fifty yards away
to our left, and the bullets came showering about our ears. They
must have caught sight of us through some opening in the trees, and
were probably waiting for just such an attempt. One of our patrol was
riddled through the stomach and back, and started crawling back on
one hand and his knees, with strange, shrill moans like a wounded
animal. The other was killed instantly. Fahey and I looked in each
other’s eyes for a startled moment; each, I think, wondering why the
other was not killed. A bullet went through the tube of my gas mask,
as I noticed later. Fahey lifted his eyebrows and pointed at the new
gun. I nodded, and we started for it. But the first gun’s crew heard
the cries of the wounded man, and traversed back and forth by us.
Fahey staggered, shot through the chest. We could not see to throw
a bomb, and it would probably hit a branch and light on us anyhow.
Our slender chance vanished, and we slipped back through the
trees.
As we returned, I saw our left flank retiring in some disorder, further
confusing our hard pressed right. The enemy had driven back the
post holding the head of the ravine on our left, and we were in the
desperate position of being enfiladed from both flanks. Our losses
were heavy, and ammunition was very low.
I glanced at my watch—only 6:20. No chance for the Lt. Col. to have
gotten a counter-attack under way. The position had become
untenable, and at any moment might develop into a complete cul-de-
sac. It was time to pull out.
I gave the order to withdraw by squads and fall back to the old
outpost line; 4th platoon to go first, covered by the 1st and 3rd; then
the 4th platoon to cover our withdrawal from the other side of the
wire.
As the first squad from the 4th platoon started through the wire, a
machine gun opened on the wire and the road before it, killing two
and driving the rest back. The platoon leader reported that it was
impossible to get across.
To remain, however, meant almost certain death for all, with very
little chance of inflicting compensating losses on the enemy. So as a
last resort I took the 1st platoon, and during a momentary lull in the
firing we made a rush for it in two or three groups at different places.
The wire clawed and tore at us as though it were alive. My group
scrambled through, somehow, anyhow, marvelling that the bullets did
not come. When half way through I noticed that I was still
mechanically holding Fahey’s bomb, with the pin out. I went a bit
carefully after that, so was the last one through. As I ripped my
puttee free from the last strand of wire, the machine guns started up
again, and I hugged the dirt while bullets cracked viciously overhead.
The grass and green leaves felt cool and smelled fresh and green,
and a little green bug went scrambling along a creeper, two inches
from my nose.
Presently another lull came, and I proceeded to worm my way
through the underbrush, looking for my half platoon. Not a sign of
them. They had gotten clear of the last burst of fire, and then made a
break for it.
The machine guns were still firing intermittently, but I heard no reply
from our rifles, and hoped that the others had followed us through
the wire. Most of them had, as I found out later.
Then came the hardest moment of the war for me. A group of about
20 men had remained on the hill, apparently despairing of crossing
the wire alive. An officer was with them, and upon him lies the
responsibility of what happened. The men themselves had done
brave service before that time. But, as I understand by permission if
not under orders, they raised the cry of “Kamerad.”
When I realized that this had really happened, I tried desperately to
cross the wire to them again. But I was in too big a hurry, and made
too much noise. The machine guns spotted me promptly, and
streams of bullets made the sparks fly from the wire six feet ahead of
me. Before I could work around to another place, I heard the sound
of their withdrawal toward the German lines, and knew I was too late.
My next job was to get back to the old outpost line and take charge
there. The enemy machine gunners had penetrated well to our rear,
and I had to go very cautiously, hearing their voices all around. They
were withdrawing, however, and in ten minutes I found out why.
Their artillery completed the day’s work by shelling the ravine and
vicinity in their usual methodical manner. Not to be outdone, our own
artillery did the same. This was the last straw; I was too dead tired to
dodge American shells as well as German. So I crawled under a
bush and waited for whatever was on the cards. In two minutes I
dozed off, with the shells banging all around.
I must have slept for about twenty minutes. Waking with a start, I
found dusk setting in. I took off my tattered slicker and wound it
around my tin hat, to keep the twigs from playing an anvil chorus on
it. The shelling had stopped. My short rest had revived some interest
in life, and I slowly retraced our advance of that morning. I didn’t
think the enemy had left any outposts behind, but in any case was
too tired to care, and went clumping along like any Heine. I arrived at
our old outpost line, which we had held long, long ago, it seemed. It
was absolutely deserted. I went along the path, past D Co.’s
headquarters, and noticed that a shell had landed there and set off
those pyrotechnic signals which had been quite fireproof two days
before.
Apparently the war had been called off around here. I pottered about
for quite a bit, but could find no one. Somehow my principal feeling
was an immense relief that for the present I had no responsibility, no
one to look out for but myself. Presently, however, it was evident that
as I had not even a runner, I had to go back to Bn. Hdq. myself and
report on the situation.
Wearily I plodded off, back over Dead Man’s Hill. It was quite dark,
about 11 P. M., and I was making very slow time. As I drew near the
main line of resistance, I came upon two D Co. men, lying where
they had been hit by a shell. One was dead; the other had a leg shot
off. He said he had been lying there for about three hours. His
comrade had helped him tie up his leg before he died. I left my
blouse over him, as it was chilly, and went on to the firing trench,
which had wire in front of it by this time. I had some trouble
convincing the occupants of my identity. In truth, with no blouse, my
ragged slicker draped about my helmet, the shoulder of my shirt all
torn and bloody, and my breeches and puttees in tatters, I didn’t look
much like an officer, and not at all like a gentleman.
I stumbled down the ramp into Bn. Hdqrs., where I found Maj. Odom,
Foulkes, Strawbridge and Lt. Col. Budd, to whom I reported. Capts.
Markewick and Laing, of “I” and “L” Cos., were also there. Thinking
the position in front was strongly held by the enemy, the idea was to
send these companies up at dawn behind a rolling barrage to re-
establish the outpost line. I was glad to tell them that this was
unnecessary, and they later strolled on up in single file and occupied
our old line without a single casualty.
Major Odom in turn told me that Lt. Dunn with most of the 1st and
2nd platoons had already come in, and had been sent to the kitchen
for chow. Louis Foulkes gave me some water and a couple of
doughnuts, which I was nearly too sleepy to eat.
I had to report to Regimental Hdq. then, and rehash the day’s
operations; but all I remember is that Capt. Brennan gave me some
grape jam and bread and water, and the regimental surgeon
swabbed my shoulder with iodine. I have some hazy recollection of
the Colonel himself pulling a blanket over me, though this may not
be correct.
Late next morning I woke up to be greeted by Strawbridge with the
news that our travel orders had come, and we—he, Capt. Brennan,
and myself—were directed to be at Langres—wherever that was—by
October 1st.
As soon as possible I rejoined the company, which had been
stationed at Brigade Reserve with the remnants of D Co. We had
about 50 men left, not counting 20 who were on various special
details. Sgt. Wilson and the cooks fed us like lords, and we made up
for the past week. Big shells landed around occasionally, but it was a
Philadelphia Sunday compared to what we had just left.
The company was reorganized as a platoon, with Lt. Dunn in
command and Reid as top sergeant. We slept in pillboxes or gun
emplacements, or anywhere else where there was a bit of shelter.
The next day I said goodby to the company for six weeks, as I
thought. There were rumors that the Bulgarians were nearly done,
and the Austrians weakening; but I don’t think that anyone dreamed
that the armistice was only six weeks off. I stopped off one night with
Sgt. Stiles to write up the company records, and finally boarded a
motor truck for Toul.
From this point the history is taken up by Lt. Gardenier, Sgt. Stiles,
Sgt. Peter and Sgt. Tracy White.
 CHAPTER VII
MEUSE-ARGONNE
Sept. 28th: Today the company commander left the company,
leaving same in charge of Lt. Dunn, the only officer left. He
reorganized the company—two platoons of about 40 men each was
our strength. We remained in reserve in the Bois des Grandes
positions until the night of October 4th. It was during this period that
rumors of the enemy countries, Bulgaria, Turkey and Austria having
quit reached us, causing a great deal of discussion and doing much
to keep the morale at its highest. Sergeant Reid left for Officers’
Training School.
Oct. 4th: “We are going out for a rest”—These words were heard all
through the company. Shortly before dark we left our position and
marched to the road that led through Limey and remained there until
midnight. We then started on what was one of the most tiresome
hikes we ever experienced, and finally, at 5:30 A. M., reached the
forest de la Reine. A fact that is worthy of mention and probably
refreshes the reader’s mind of incidents of the night was what
seemed to be a direct hit on an ammunition dump to the right. The
sky was brilliantly illuminated and was the cause of numerous
rumors and suggestions as to the reason of the glare. We remained
here until about 4:00 P. M. October 6th, and then started off for what
we fondly believed was a rest. Subsequent events proved that our
hopes were not to be fulfilled. It was here that Lt. Luhn joined the
company. After hiking until midnight, most of the time through rain,
we reached Mecrin and were so tired that regardless of the weather
we threw ourselves on the ground and without further aid went to
sleep until the following morning. Sgt. Perry rejoined the company at
this place. At 11:30 A. M., we started again on a hike to Pierrefitte,
arriving at 10 P. M., having covered about 24 kilos. It was again our
fate to have mother earth for a bed this night.
From here we hiked a short distance to Nicey, where we took busses
for a 40 kilo trip to Beauchamp Ferme in the Forest de Argonne,
arriving about 10 P. M. in what seemed to be the darkest spot on
earth. As usual it was raining, and this added greatly to our
discomfort. There were only sufficient barracks for one company, the
rest of the outfit had to sleep in their shelter tents, pitched in spots
that were not very appealing when revealed at dawn. Lt. Dunn
having been ill for some time left us here and Lt. Lahey took
command of the company, having been transferred from Company
“I.” Sgt. Perry having been made 1st Sergeant upon his return to the
company aided materially in reorganizing the company. We had a
few days of much needed rest here and also consumed quantities of
wood in making bonfires that dried us out and made life a little more
cheerful.
At 2:00 A. M. October 10th we aroused from our slumbers with
orders to roll packs and be ready to leave at once. This was another
example of how things are done in the army. Having spent several
hours in rolling packs and getting breakfast, it was 7:30 A. M. before
we started out. Our hikes of several days previous to arrival at this
camp had taken us through many ruined villages and parts of the
country recently evacuated by the enemy. Today’s hike covered 22
kilos and brought us into the heart of the Argonne, the same ground
having been bitterly contested by opposing armies only a week
previous. It was here that we were able to form a definite idea of how
the Germans lived behind the lines. Every hillside was covered with
dugouts made of concrete and heavily timbered and furnished in a
style that had been unknown to us during the past four months. In
the Limey Sector we found some German camps that were fitted up
in grand style, but these could not be compared with the ones
mentioned above. The officers’ quarters were equipped with shower
baths and in one place a large swimming pool. Everything seemed to
denote that the Germans intended to stay there for all time. The
signs on the trees and every crossroad led one to believe that the
Germans were a nation of sign painters. Arriving at our destination
after hiking about 23 kilos we appreciated an opportunity to rest and
lost no time in pitching tents and getting a much needed sleep.
The following day we marched about 4 kilos and took up a position in
the Bois de Chatel. It was here, on the eve of October 12th, that our
much battered company of approximately 80 men, all veterans of the
St. Mihiel, received 104 replacements from the 86th Division. Some
of these men had never fired a rifle and were not familiar with the
use of the gas mask. The company was again reorganized. The four
platoons were placed in charge of Sergeants Newell, Lehy, White
and Weber, respectively; to these men and our two officers, Lts.
Lahey and Luhn, is due the credit of training these new and
inexperienced men so that when they were called upon they made a
creditable showing. Too much cannot be said about the way these
men took care of what seemed to be almost a hopeless task.
October 15th again brought us under shell fire. About 8:00 P. M. we
left our positions and marched through heavy rains to relieve a unit
of the 308th Infantry, west of La Folie Ferme. We took up our
position about 3:00 A. M. and despite the fact that we were wet
through, made ourselves as comfortable as circumstances would
permit, only to be awakened at 5:30 A. M. to prepare to advance at
once. While preparing, Jerry saluted us with a barrage that, while it
lasted, was very annoying and upset the new men exceedingly, this
being the first time they had ever been under shell fire. This lasted
only for a few minutes and after their baptism they all acted like
seasoned veterans. This relief having been made during the
darkness of the night, the units encountered great difficulty in
keeping the men together. There was considerable mixup on the
road that led to Chevieres; three columns of troops and a transport
train trying to pass at one time. This caused a great deal of
confusion and the result was that many of the new men became
separated from the company and did not rejoin us until the following
morning. On October 17th Sergeants Levy and Wilson left for
Officers’ Training School. This morning we lost Sergeant Lehy; he
was killed just one hour before he was ordered to leave for Officers’
Training School.
Oct. 18th: At 10:00 P. M. we took up a position in the front line to the
west of Chevieres, relieving our 2nd Battalion. At 3:00 A. M. we
stepped off in a line of combat groups in support of “C” company,
and advanced through heavy artillery and machine gun fire. We
reached our objective at daybreak and held same through the day
under continual fire from the enemy snipers and machine guns.
Enemy planes endeavored to locate our position and flew so low that
the aviators were easily seen. Their object no doubt was to signal
their artillery the location of our position, but judging from the heavy
barrage that fell directly in back of us, their efforts were not crowned
with success. We suffered quite a few casualties during this attack,
among whom was Sgt. Welch, who had been recommended for a D.
S. C. for bravery at St. Mihiel. He was wounded in seven different
places by machine gun bullets, but refused to be evacuated until the
other wounded men had been taken care of. Owing to our advanced
position, and both the units on our flanks having failed to obtain their
objectives, we were subject to such a heavy fire that it was
impossible to evacuate our wounded until dark. Toward evening the
enemy closed in on both flanks, and on our front, making our
position untenable, and under cover of darkness drew close enough
to drop hand grenades among our fox holes. This caused our
officers to call for volunteers to carry a message to the Battalion
Commander. After several runners had failed to get through, Sgt.
White had volunteered to carry the message and reached Battalion
Headquarters P. C. in safety and returned with instructions to have
the company withdraw. He was awarded a D. S. C. for this brave act.
His entire route was continually subject to heavy artillery and
machine gun fire. By performing this deed he undoubtedly saved
many lives and enabled the company to make an orderly retreat to
the position they left that morning. He also assisted in directing the
evacuation of the wounded; every man was removed without further
casualties. During the activities the enemy continually sent up
rockets and flares so that our movements could only be made during
short minute periods of darkness. Too much credit cannot be given
to both Lt. Lahey and Lt. Luhn. Their bravery and unselfish action in
face of the enemy did much to keep up the morale of the men. We
fell back to the position we had left that morning, and remained until
6:00 A. M. Then we fell back to railroad track running from Chevieres
to Grand Pre, where we remained about four hours and then
advanced again and took up our position along the River Aire. Here
we remained for nine days and nights under continuous shell fire.
While we suffered no casualties at this place from the enemy fire,
several of our men were evacuated with influenza. One great
difficulty that we experienced here was that of obtaining rations, as it
was impossible to bring them up during the day, and at night Jerry
threw over such a heavy shell fire that made the work of the ration
parties extremely hazardous.
On Saturday evening, October 26th, we were relieved by the 310th
Infantry and took up a position in Brigade Reserve in the Bois de
Negremont. This day Lt. Luhn was transferred to “D” Company, and
we were again left with only one officer. Having lost a great many
men, it was necessary to reorganize the company again. There were
only sufficient men left to form two platoons. This position was
subject to intermittent shell fire which caused occasional casualties.
The night of October 29th-30th will be one that will be long
remembered by those men who were present with us. The enemy
had been shelling us the entire evening without causing any
casualties. It was about 1:30 A. M. a shell, the last one he fired that
night, struck a tree directly over our camp and exploded. It killed or
wounded 14 men, and Lt. Lahey was also severely wounded. Lt.
Lahey’s bravery at this critical period was such that his men never
cease praising him. While wounded so seriously that he died two
days later, he directed the evacuation of all the other wounded men
and gave instructions to the non-commissioned officers left with the
company, before he permitted himself to be evacuated. Sgt. Newell,
then acting 1st Sergeant, was killed instantly by this same shell. Sgt.
White was now in command of the company and did excellent work
keeping the company organized until the arrival of Lt. Gardenier. The
following day, October 30th, the enemy resumed their heavy shelling
and we suffered several more casualties in killed and wounded.
During our stay in the Bois de Negremont we were fortunate enough
to get a bath by walking five miles for it, and a change of underwear,
but seldom it was indeed that we received more than one meal a
day, so continuous was the enemy shell fire.
Oct. 29th: The position of the company was still in the Bois de
Negremont, in Brigade Reserve. Pvt. Koehler was killed by shell fire
during the day. Toward evening the shelling let up and was fitful and
erratic from that time on. Lt. Gardenier arrived in the evening and
took command of the company which was at the time in charge of
Sgt. White.
Oct. 30th: The morning was spent in reorganizing the company and
issuing equipment preparatory to the drive which was to start the
following day. The company was divided into two platoons, the first
under Corporal Ahearn, and the second under Corporal Thomas
White; with Sgt. White second in command of the company. Pvt.
Koehler was buried at La Noua le Coq, near the chateau. There was
considerable shelling during the afternoon, but there were no
casualties, and the appearance of a big consignment of rations in the
evening did much to hearten the men. Enemy shell fire had
interfered with the rations considerably up to this time, as there was
but one route the ration parties could take and it seemed to be quite
familiar to the Boche artillerymen.
Combat packs were made at night and the company was ready to
move early in the morning as the 2nd and 3rd Battalions were to
attack at dawn. In the afternoon a pirate 75 was moved up behind
our position and engaged in an artillery duel with a Boche battery
until late at night. The only result being a fairly continuous shelling of
our area.
Nov. 1st: At 2:30 A. M. the barrage preparatory to the launching of
the second phase of the Meuse-Argonne opened. The sky behind us
was a flickering, gleaming red. The roar was as of myriad drums
rolling almost in unison, and the air overhead seemed almost alive
with whistling visiting cards to the departing Jerry. The effect of this
on the men who had heard little but shells coming in their direction
was tremendous. The men walked about the hills whistling and
singing and the erstwhile quiet forest was alive with conjectures as to
what was happening when the winged death that was flying
overhead arrived at its destination. After the firing had ceased there
was extreme quietness and there was no activity during the night.
Nov. 2nd: The company was held in readiness throughout the day,
and after mess in the evening packs were slung and the Battalion
moved out. It began to rain just at the start, and the path we followed
in the pitch black forest was steep and slippery. We progressed
slowly over the plain between la Noua le Coq and the Aire River and
entered the shell-torn town of Grand Pre. Passing through the ruins
along the Kron Printz Strasse, we went north to the road fork
between Grand Pre and Ferme des Loges. Here the company was
detached from the Battalion, Lt. Conroy was placed in command and
we waited for trucks to enable us to overtake the now flying enemy.
Trucks were boarded about 11:00 P. M. and we bumped over the
shell-torn road in the general direction of Germany, until our way was
blocked by a mine hole not yet repaired. We debussed and hiked to
Briquenay, where we found the 312th Infantry had the situation in
hand and with the exception of about twenty men who formed an
ammunition detail for the 309th Machine Gun Battalion, we turned
into some German billets about 2:30 A. M. The infantry advance up
to this time had been so swift that the artillery had been unable to
catch up to us, having set up their guns three times without firing a
shot.
Nov. 3rd: During the day the 2nd Battalion passed through Briquenay
and we were held there. Most of the time was spent in improvising
meals and exploring the debris left by the enemy in his hasty flight.
Toward evening about 200 American airplanes in combat formation
flew over going north. Lt. Conroy returned to Battalion Headquarters.
About 5:00 P. M. the rest of the Battalion moved out and through a
misunderstanding the company was left behind. When our plight was
discovered we set out for Germond, and after passing a Battalion of
the 308th Infantry on the road arrived just in time to get the last
available billets. Germond at that time held the four Regimental P.
C.’s of our division, one of the 77th and somewhere in the
neighborhood of 2,000 troops.
Nov. 4th: At 5:00 A. M. we started for Authe, after the heartrending
procedure of passing a battalion of the 308th Infantry lined up for a
hot meal. We went through Authe to Brieulles under fairly heavy
shell fire where the road had been blown up, six mines having been
placed at a bridge and we were forced to make a long detour
through a swamp. From there we proceeded to Les Petites Armoises
as the advanced guard of the Brigade. It was a gruelling hike and
considering the condition of the men, the spirit shown was
remarkable, and we halted south of the town only four men less than
we had left Germond with in the morning. Artillery was quite active
there and we witnessed some wonderful work by German batteries
and an airplane in destroying a group of buildings to the west of us.
On entering the town we were greeted by delighted civilians who had
been under German rule for four years and who gave us some
atrocious black bread covered with lard which almost tasted good.
They also warned us that the enemy had a machine gun nest to the
north of the village.
After deploying we started up the hill, and soon as scouts appeared
above the crest machine guns opened up on them. In the
subsequent reconnaissance Privates Sullivan and Burchell were
killed by machine gun fire. One gun was located about 300 meters in
front of us and in an effort to flank its position the right of the
company was deployed along the crest of the hill, and was in
position to rush it, but it was cut off by fire from the flank. After three
attempts Sgt. White brought the left flank to a similar position only to
have the advance halted by another machine gun. As it seemed
impossible to advance without auxiliary weapons the company was
withdrawn and dug in half way down the hill. “D” company
established contact on our left but there was nothing on our right but
German machine guns. Corporal Miller led a patrol in an effort to put
the guns out of action, but was unsuccessful because of the covering
fire from other guns and the openness of the country. About 3:00 P.
M. two airplanes arrived and one by his near presence causing a
Boche plane to retire, dropped a message which said “There are
Boche machine guns in a shell hole 200 meters to your front.” This
information was somewhat superfluous, but the affair was
interesting. The other plane, endeavoring to locate Company “D”
flew too low and landed on a hill about 500 yards in front of our line.
The aviator unhurt got out of the machine and in spite of the hails of
our outpost he headed for Germany and was seen no more. The
plane was dragged by the enemy to a point north of Tannay and
demolished. About 5:00 P. M. Boche artillery opened up and played
a steady stream of fire on the town, and by no means neglected our
position. A strong point made up of men from Company “C” was
scarcely located in their new position when a shell severely wounded
two of their men. The loss of our First Aid Man who was killed by a
shell early in the evening greatly handicapped the evacuation of the
wounded.
From 5:00 P. M. to 1:00 A. M. there was a perfect hail of shells and
machine gun bullets while enemy airplanes dropped bombs on the
town itself. Corporal Peter did excellent work during this time
keeping the outposts organized. Casualties—killed 5, wounded 9.
Nov. 5th: About 3:30 A. M. the enemy machine guns pulled out and
at 5:00 A. M. the company retired to les Petites Armoises for
breakfast and then went on to Tannay. After reconnaissance by the
Battalion a patrol of 30 men was called for to establish a strong point
in a patch of woods northwest of the town. An effort was also to be
made to obtain liaison with units on our right. The first platoon was
called upon and though practically exhausted they responded
promptly and went up to take their position. Lt. Gardenier with three
runners went on until contact was established with the 165th Infantry
just north of Sy. Sgt. Ahearn meanwhile, finding no opposition in the
woods designated, pushed his jaded men to the edge of the Bois de
Mont Diens, about two kilometers further on and began to exchange
courtesies with a lonely machine gunner. To this detachment belongs
the distinction of being the unit of the 78th Division nearest Germany
when the relief came.
When the 166th Infantry had leapfrogged us at 3:30 P. M., the
company pulled back into Tannay at 4:15 P. M. just in time to begin
hiking back. It was raining again, and it was a dismal hike to Les
Petites Armoises where no billets were available, and the only
alternative was Brieulles, 7 kilometers further on. Over a road pitted
with shell holes, filled with troops, transport and artillery headed in
the opposite direction, the company plodded on, arriving at Brieulles
about midnight. A conservative estimate of the distance covered by
the first platoon that day is thirty kilometers and all under the most
trying conditions. On reaching Brieulles we shared a church with “C”
company and while some sat up and others stood crowded into
corners, everybody slept. We left Brieulles at 5:00 A. M. and hiked to
Authe where, Nov. 6th, a hot breakfast put new life in the company,
which was fortunate, because though we did not know it at the start,
there were twenty-two gruelling kilometers in front of us. After hiking
continuously until 5:30 P. M. we reached La Folie Ferme and stayed
the night in these familiar haunts.
Nov. 7th: Packs were slung and we were on the move early in the
morning and after hiking until 4:00 P. M. we were presented with a
soaked, battered section of the Argonne not far from Appremont, and
told to make ourselves comfortable. We were doing the best we
could when there was an unholy din and a fireworks display, owing
to a signal corps outfit hearing “Officially” that the war was over. We
mistook it for a German air raid, however, so we did not derive much
comfort therefrom. But it is worthy of notice because it was the
beginning of the greatest conglomeration of rumors in the history of
civilized warfare.
Nov. 8th: It took most of the day trying to follow out the order to make
ourselves comfortable and we were just beginning to accomplish this
when on the morning of November 9th we pulled out and hiked to
Florent, remaining there the following day. Lt. Gartley, who had
joined on November 8th, assisted the company commander in re-
acquainting the jaded doughboys with the intricacies of the manual
of arms and that evening the pearly notes of “Retreat” and The Star
Spangled Banner made us feel nearly civilized again. The rumors
were still running high.
Nov. 11th: On this historic day the 1st Battalion celebrated by taking
its longest hike of the Meuse-Argonne Campaign. We moved from
Florent to Varimont, a distance of twenty-nine good long kilometers.
While we were passing through Ste Menehould, the French papers
with gigantic headlines “C’EST SIGNE” were shown us and we
passed innumerable grinning French men and women repeating
over and over again the words which were like music to our ears
—“la Guerre Finie.”
We arrived at Varimont about 5:00 P. M. nearly exhausted and
resumed back area existence at once.
Nov. 12th-14th: Our stay in Varimont was punctuated by determined
efforts to get separated from Argonne Mud and getting policed up
and generally put in shape for a Fifth Avenue parade, which was to
come off very soon. Lt. Gartley left for the 1st Division.
Nov. 15th: The company moved to Givry-en-Argonne to act as a
loading detail for the Brigade which was to entrain, and the following
day was spent in that occupation.
Nov. 17th: The company entrained about 11:00 P. M. and started on
a two-day journey to Les Laumes, where they arrived about 3:00 P.
M. on the 19th. With much grunting and puffing the initial ascent of
the now well known hill was made, and about 5:00 P. M. we arrived
at Flavigny, which was to be our home until we began our journey
homeward.
 CHAPTER VIII
FLAVIGNY-SUR-OZERAIN
It might be interesting to insert here a brief description of Flavigny,
taken from a letter written home by one of the men:
“To say the least, Flavigny is a town that is somewhat interesting.
There is a bit of history attached to the place in that we are told that
Caesar fought a battle against the Germanic people in this
neighborhood about 55 B. C., using the plateau across the valley as
his base for operations against a town a few miles from here.
“Flavigny was then standing on its present site, although, perhaps,
much smaller than it is today, and there are no evidences that any of
the buildings then existing are now standing. It would hardly seem
possible that they could be. Today, the village stands on the top of a
high plateau, which is reached by a road winding around the
mountain. Although it was a cold dismal day when we came here, we
were dripping with perspiration by the time we reached the top.
“It is a walled village—part of the wall being formed by some of the
buildings—having three entrances large enough for vehicles and a
fourth one large enough for only persons or animals in single file.
The main entrance, ‘La Porte du Bourg,’ opening to the road up
which we came and which seems to have its ending in the centre of
the town. About a quarter of a mile before reaching the town this
road branches off to the left, winding around some farm buildings,
and running along the outside of the wall overlooking the valley, and
as it passes the rear of the village making a steep descent into the
valley again.
“Opening into this road at about the centre of the village is the
second entrance, ‘La Porte du Val.’ While this entrance seems to be
of less importance than the others, as it is reached from the inside by
a narrow alley, yet it is well protected, or was considered so as
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